Notes

Capitalizing on Early Stage Companies Through Capital Table Management
A Capital Table is basically a table giving an assessment of the proportions of ownership, total equity, dilution of equity, and net worth of an enterprise during each successive round of commercial financing. The table gives the effect of cumulative changes in the value of ownership over time, allowing the enterprise to keep track of its exposure to risk and the impact of inflation on its value. The effect of inflation can be significant to enterprises that derive most of their revenue from sources outside of their business. Expenses associated with operations outside the business can affect the net worth of the enterprise.

The purpose of the capital table is to allow management to make informed decisions regarding financing, ownership structure, and working capital. The shareholders of an enterprise can generally make better informed decisions concerning activities and expenses than owners. Owners cannot reasonably make such assessments as well as do not have a similar history or are exposed to similar risks. A capital table is essential to the success of any business enterprise. A properly administered cap table will allow the owners to participate in business activities without worrying about whether they will lose money.

Before making the capital table, there are several things to consider such as the relationship of the business to its competitors, the nature of the products or services provided by the business, and the capital structure. One very important issue that must be addressed is the shareholding pattern of the founders. The owners may share equally in the ownership of the enterprise or they may divide their shares amongst other people.

Shareholders usually prefer capitalizations that are divided between equal shares of ownership rather than one-owner operations. In some circumstances, however, it makes sense to allow the founder to exercise their option to buy out or sell their shareholdings even after they have sold all of their shares. For example, if the founder has raised enough capital from investors to start operating the business and the company is successfully launched, they may choose to exercise their option to buyout other shareholders' shares and create a newly funded and dilapidated business.

It's important for the new business owners and employees to understand the meaning of the cap table. The cap table tells the investors what percentage of the capital will go to the initial investors and what percentage will go to the employees. It can also show the value of shares outstanding by each shareholder and the effect that these outstanding shares will have on the value of the company. Most investors will use the cap table to calculate the cost of capital for each of the startup businesses they are considering funding.

The gap table is different from the FMV in that it doesn't include an intrinsic value figure for the business. Instead, it is based only on net present value - what the current value of the assets of the business is less than their replacement value. The gap table is not dependent on whether the shareholders will exercise their right to vote or not - they will do that later. Their computation is simply based on what the current value of the business is less than their estimate of the business's probable income over the next five years, or at the most, the amount by which the equity grows minus the net worth (the difference between value and liabilities) of the business at the time of purchase.

The question on the minds of many small-business investors is this: is it really hard to understand the formulas and the definitions? And if it really is hard to understand them, why do people recommend that the purchasing of preferred stock or other equity compensation be done only through brokers? It can be really confusing for a small investor to understand the formulas and the explanations provided by the brokerage firms about how these formulas work. Often, these recommendations result in brokerage firm owners convincing investors that they are buying really good equity compensation when in reality, they are just purchasing a company share at a price that has already been determined beforehand.

For new and small investors, capitalization table management and its necessity for early stage companies are really confusing and this can lead to bad investment decisions, or worse, fraudulent transactions. In a nutshell, for any potential buyer, a capital table must be clearly defined and must include the information that the seller wants to have. Otherwise, an investor who is not knowledgeable of the cap table calculations may be pressured into purchasing shares of company ownership that he does not really need.
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